Nationalize Benchmarks not Banks.
Car company’s own cars building and selling but not roads on which cars ply or the traffic signals that control flow. If this is not true then when a car manufacturing company is shuttered down due to its inefficiency it can bring entire system to grinding halt. I think current credit crisis is classic analogy to this point. Banks are intermediaries and risk takers. They are intermediaries with respect to credit flow. This way they help match savers to borrowers effectively. They are also risk takers. In this regard they are leveraging on their knowledge to bring value to their shareholders. In this process they are creating benchmarks and these benchmarks are becoming benchmarks for their credit business activity.
Common people need money to borrow for a house, car and to pay for collage. They do so because it will take a life time to save all the money needed to perform these activities. If there is a credible way they can pay back the amounts in small monthly installments then they are willing to borrow. Now these loans are made by banks using various benchmark indices like prime rate, 10 yr Treasury note and some are directly related to libor instruments. Federal Reserve can impact prime rate by cutting or hiking fed funds rate. But they cannot regulate rates like libor. These rates are set by banks.
Now, last few years as technology has evolved finance engineering also grew to the occasion. This created novel way to price the products and securities. This allowed bankers to create wide array of products. Its like if you walk in an aisle in a supermarket you will see 10 different selections for simple milk. Depending upon your palate and tolerance you buy a particular kind of milk. Similarly there are tons of different products to make a choice. So people go to bank and get the kind of loan they need based on their credibility.
Currently, we are in the midst of big recession. Credit flows are all but stopped. When common people are still paying their loan commitments and plenty of new people want to get loans to start on their own creative activities. This activity is stalled completely. Government is creating TARP, TALF, rate cuts, and mortgage security buying, Quantitative easing and also planning to legislate to put a cap on mortgage rates. On the other hand, people are getting laid off; companies are winding down and thus creating a vicious circle of traffic jams.
So what went wrong? Banks have taken risks without impunity? No, banks did their job. Only one thing they have done correctly so that they will be bailed out in the event of mishap is tying credit activities to bench marks of their own creation. Government should help get into the business of maintaining these high speed lanes of credit benchmarks. This way no single bank can be labeled as too big to fail. If a bank has failed in discharging its obligations then let it close. But it should not be allowed to take the system down. Now question is the leverage taken by banks. For instance, Lehman bankruptcy created a situation where unwinding of the contracts traded by them created market dislocations. Market dislocations are like battle scars or minor injuries in the long life of the active economic life. But today, media fills the people’s ears with fear and greed and directing people to act like herds at their beck and call. Mortgages, car loans and student loan activity should be tied to benchmarks and securitization should be tied to again benchmark rates only. It’s the interbank spreads that unleashed havoc on the credit flow activity. Therefore we need not nationalize banks, nationalize the benchmarks. Nationalize the LIBOR rate setting activity. Like roads and traffic lights govt should own indices for loan creation. Banks should innovate their ways to create new structures. Govt should own the indices that allow the structures to thrive.
Car company’s own cars building and selling but not roads on which cars ply or the traffic signals that control flow. If this is not true then when a car manufacturing company is shuttered down due to its inefficiency it can bring entire system to grinding halt. I think current credit crisis is classic analogy to this point. Banks are intermediaries and risk takers. They are intermediaries with respect to credit flow. This way they help match savers to borrowers effectively. They are also risk takers. In this regard they are leveraging on their knowledge to bring value to their shareholders. In this process they are creating benchmarks and these benchmarks are becoming benchmarks for their credit business activity.
Common people need money to borrow for a house, car and to pay for collage. They do so because it will take a life time to save all the money needed to perform these activities. If there is a credible way they can pay back the amounts in small monthly installments then they are willing to borrow. Now these loans are made by banks using various benchmark indices like prime rate, 10 yr Treasury note and some are directly related to libor instruments. Federal Reserve can impact prime rate by cutting or hiking fed funds rate. But they cannot regulate rates like libor. These rates are set by banks.
Now, last few years as technology has evolved finance engineering also grew to the occasion. This created novel way to price the products and securities. This allowed bankers to create wide array of products. Its like if you walk in an aisle in a supermarket you will see 10 different selections for simple milk. Depending upon your palate and tolerance you buy a particular kind of milk. Similarly there are tons of different products to make a choice. So people go to bank and get the kind of loan they need based on their credibility.
Currently, we are in the midst of big recession. Credit flows are all but stopped. When common people are still paying their loan commitments and plenty of new people want to get loans to start on their own creative activities. This activity is stalled completely. Government is creating TARP, TALF, rate cuts, and mortgage security buying, Quantitative easing and also planning to legislate to put a cap on mortgage rates. On the other hand, people are getting laid off; companies are winding down and thus creating a vicious circle of traffic jams.
So what went wrong? Banks have taken risks without impunity? No, banks did their job. Only one thing they have done correctly so that they will be bailed out in the event of mishap is tying credit activities to bench marks of their own creation. Government should help get into the business of maintaining these high speed lanes of credit benchmarks. This way no single bank can be labeled as too big to fail. If a bank has failed in discharging its obligations then let it close. But it should not be allowed to take the system down. Now question is the leverage taken by banks. For instance, Lehman bankruptcy created a situation where unwinding of the contracts traded by them created market dislocations. Market dislocations are like battle scars or minor injuries in the long life of the active economic life. But today, media fills the people’s ears with fear and greed and directing people to act like herds at their beck and call. Mortgages, car loans and student loan activity should be tied to benchmarks and securitization should be tied to again benchmark rates only. It’s the interbank spreads that unleashed havoc on the credit flow activity. Therefore we need not nationalize banks, nationalize the benchmarks. Nationalize the LIBOR rate setting activity. Like roads and traffic lights govt should own indices for loan creation. Banks should innovate their ways to create new structures. Govt should own the indices that allow the structures to thrive.
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